The flavor of the month has been the launch of Nano by Tata motors. The Nano launch got an extremely wide coverage in media, which is something only Apple’s products are able to get.

My interest around the launch of Nano has been more in terms of the impact on Maruti suzuki. Maruti suzuki is a holding for me and I have analysed the company in the past ( see here and here ).

The percieved threat to Maruti from Nano has been known for quite sometime now. The reason I use the word percieved is due to the fact that I don’t consider this as an immediate threat, but a long term one. Let me explain

The product which is supposed to be impact by Nano is Maruti 800. However this model has been in a state of decline for the company for the last couple of years. In the year 2007, even before the launch, the product had volume decline of 10%+ and now accounts to barely 10% of the sales volume and must account for less than that in terms of profits (I don’t have the profit contribution for Maruti 800, but we can safely assume that the margins for this model are less than the higher end products). As a result, Maruti suzuki seems to be consciously moving out of the lower end of the market and the launch of nano could accelerate the process. Any further loss of volumes in Maruti 800 should not hurt the company much.

So much for the short term. What about the long term ? That is different story. For reference, let me point out the book – The innovators dilemma by Clayton M. Christensen, which talks in detail about disruptive technologies. I cannot explain the key concepts in a short post and would recommend reading the book or using this link.

The key point is that some companies introduce disruptive products at the low end of the market which meet only a subset of the requirements and cannot meet the requirements of majority of the users. These disruptive products or technologies are ignored by incumbents, as they are cheap, low margin and a threat to the current business model and products. However with the time the disruptive companies keep improving these cheap, disruptive products which then become good enough to threaten the mainstream products. A well know example – Personal computers.

Tata’s nano can be a disruptive product in the long term. As of now, this product will not threaten Maruti suzuki and other companies or their profits. But if Tata motors gets it strategy right and keeps improving the product, then they could be a major threat to the other companies.

It is however not a given that the above will happen. It will depend on how the other car companies react. However irrespective of the response, if the Nano is successful, it will affect the profitability of most of the car companies in the long run. I would recommend reading – Clayton M. Christensen’s books to understand how this has typically played out in other industries and you will appreciate how the same could happen in the car industry.

All of the above is still in the future. For the time being, everything is bright and sunny and investors like me in maruti suzuki are not complaining. However, due to the above market dynamics I do not plan to hold the stock for more than a few years (yes my concept of long term is more than a few months 🙂 ).

I recently read the news on suspending AS11 accounting standards for the next 2 years in view of the dramatic changes in international markets. In the last one year, the rupee has suddenly depreciated from 40s level to 50s declining by more than 20% during this period. Most of the companies were caught by surprise as they did not expect the rupee to depreciate so sharply and hence are facing MTM (mark to market) losses for the current year.

AS11 is a standard for recognizing impact of forex changes on the company’s accounts. I have the discussed impact of forex changes in my discussion of NIIT tech. I have said the following in the past

The current quarter results show a bottom line drop of around 50%, mainly due to forex losses. I do not consider them as core losses (just as forex gains are not permanent gains). I have seen a lot of people get all worked up about forex losses, which does not make sense to me.
Unless the company is speculating on forex (via non effective hedges), I think the forex gains and losses should even out over the period of few years and hence one should be concentrating on the core profits to value the company.
As an example look at the results of the airlines such as southwest (in the US). Southwest airlines has been consistently profitable for the last 20+ years. They have had 2-3 quarters of hedging related losses due to oil price volatility. Do you think they have a problem in their core operations?

So if I have considered these losses to be temporary, akin to a bad bet, then why am I not applauding this temporary suspension of the standards?

The reason is simple – I want my companies to give me the true picture. Don’t fudge, whitewash or hide information from me (as an investor). Please tell me the whole truth and leave it to me to judge the impact of it. As investors we are smart enough (as a group) to judge the impact of forex changes on the long term economics of the companies and don’t need the companies to whitewash this information for me.

Now that we are in the territory of fantasy accounting, I have a few more proposals

– Ignore cost increases of raw material when they become too high. When steel prices increase sharply, all auto and other companies should be allowed to ignore price increases
– Ignore manpower costs and salary hikes. Allow all IT companies to ignore salary hikes in excess of 5%.
– Ignore depreciation after a huge capex. Whenever the company puts up a new plant or makes a big accquisition, allow it to ignore depreciation and amortization expenses

I could go on and on. The above change is self serving and will only muddy up the numbers. It allows the companies to present the numbers in a good light and ignore reality. Is it a given that the rupee will appreciate to 40s level in 2 years and all will be great in the fantasy land?

I personally don’t care what companies report by suspending AR 11 for 2 years. I will personally adjust the numbers of the companies I have invested in or plan to, based on the forex changes.

I really wish I had this flexibility when I was studying !! I would have asked the examiners to ignore all the question I got wrong and I would have always got 100% in all my exams 🙂 . Life would have been good !!

I am mad ! very very mad. See this news item on novartis india.

Novartis AG has announced an open offer for Rs 351 per share with the aim of taking their shareholding to 90%. Although they have not stated any plans for delisting, I think once the shareholding reaches 90%, delisting norms could kick in and the rest of the shareholders will be forced to exit the company.

Why am I mad ? See my analysis of novartis here. My conservative estimate of the intrinsic value is around 600-650 (company has a cash of almost 150 rs/ share). Look at it this way – Net of cash, the buy back offer is valuing the company at 800 crs. This is for a company making almost 100 Crs of profit on a capital base of around 30-40 Crs !!

Another view point – The buyback offer will cost the company around 440 Crs. The company has cash and equivalents of around 435 Crs as of december 2008. So the Parent company will be able to increase its holding to 90% without spending a penny from their pocket !!

Should I feel cheated ? May be not. I have known this modus operandi for some time. A lot of MNC’s have cheated their minority shareholders this way. The steps are as follows

– Allow the performance of the company to stagnate for a few years by avoiding product launches and anything else which enhances value
– Hold all the surplus cash during this time period.
– Wait for a bear market to drive your price down to very low levels.
– Announce an open offer at premium to current price, utilising the cash holding
– Try to mask this operation as a shareholder friendly operation by pointing out that the price is at premium to the current price (which is way below intrinsic value).

I have known and written the above earlier on my blog. I have however chosen to ignore my own advice though and would now be paying for it. At the current price, net of dividends, I have made modest returns. However that is not the point – The point is being treated fairly by the management of your company.

Another case – Ingersoll rand : They have announced their intention of coming out with an open offer too. I am not holding my breath on that as they have tried a similar tatic in the past, but were not successful in completing the buyback.

Lesson for me : Management matters more than i would like to accept. A good business with bad management will translate to poor returns.

What next ?
I am going to wait and watch how this open offer will play out. However even if the minority shareholders reject it, don’t expect the management to change or mend their ways. They will continue to ignore the minority shareholder, give poor dividends and will continue to accumulate cash. The best startegy in such a case would be to exit the stock and deploy the capital somewhere else.